European Regulator to Revise Pillar 1 to Include ESG Risk

European investment firms and banks will soon be required to adjust their risk assessments to factor in environmental and social risks, which Europe’s banking regulator says could threaten the stability of the entire financial system.

The European Banking Authority is calling for financial firms to accelerate the integration of environmental and social risks within capital requirements known as Pillar 1, which requires firms to calculate minimum regulatory capital for credit, market and operational risk.

A recent report from the regular stated that environmental and social risks are changing the banking sector’s risk profile and are expected to become more prominent. It suggested revisions of the Pillar 1 framework to reflect the growing importance of environmental and social risks. According to the EBA, the proposed changes are intended to support the transition to a more sustainable economy while also ensuring that the banking sector remains resilient.

“Economies and societies are increasingly facing the complex and severe consequences of

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climate change, biodiversity loss, resource depletion, inequality, migration and other

environmental and social concerns,” the report stated. “Through their effect on traditional categories of financial risks, such as credit, market and operational risks, environmental and social factors are expected to more significantly contribute to risks to both individual institutions and financial stability as a whole.”

The EBA is proposing five short-term actions for firms to take over the next three years:

Include environmental risks as part of stress testing programs;
Include environmental and social factors as part of external credit assessments by rating agencies;
Include environmental and social factors as part of due diligence requirements and valuation of immovable property collateral;
Identify whether environmental and social factors constitute triggers of operational risk losses; and
Develop environment-related concentration risk metrics as part of supervisory reporting.

The EBA’s report also noted that it has considered introducing risk-weighted adjustment factors known as green supporting factors and brown penalizing factors. GSFs are intended to reward so-called “green” investments by reducing capital requirements for environmentally sustainable exposures, while a BPF aims to punish investors by increasing capital requirements for environmentally harmful assets. However, the EBA does not believe they should be introduced “at this stage,” noting that the use of the adjustment factors presents challenges in terms of design, calibration and complex interaction with the existing Pillar 1 framework.

“The EBA will, pending progress to overcome the challenges associated with such adjustments, reassess if and how environment-related adjustment factors could be designed as part of a prudentially sound and risk-based prudential treatment of individual exposures,” the report stated.

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Tags: Banks, brown penalizing factors, EBA, environmental risks, ESG, European Banking Authority, green supporting factors, pillar 1, risk assessment, social risks

The CIO of the Illinois State Universities Retirement System, Doug Wesley, will retire from his role after seven years at the helm and 30 years with the organization. He will stay in his current position until retiring on March 1, 2024.

“I strongly believe that SURS makes a difference in people’s lives and I’m thankful for the opportunity to contribute towards that mission,” said Wesley in a press release. “I am grateful to the executive team and staff for making this a great organization. Last, but certainly not least, I want to thank the investment team for their support and dedication.”

The organization’s longtime deputy CIO, Wesley was appointed interim CIO in August 2016, following the retirement of Dan Allen, and appointed to the long-term job in March 2017 by the fund’s board of trustees.

“The SURS Board of Trustees wholeheartedly thanks Doug for his years of service,” said SURS Investment Committee Chair Scott Hendrie. “His knowledge, leadership, hard work, and wise advice are pillars to the success of this fund. We wish him the best in retirement.”

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The State Universities Retirement System of Illinois serves nearly 250,000 current and former faculty and staff of state universities. As of June 30, SURS managed $23.2 billion in assets, but the system has a history of chronic underfunding, including a 45.2% funded ratio through fiscal 2022.

“The majority of the annual state contribution to SURS goes to pay down the costs of decades of underfunding by the state,” the SURS website states. “For example, in [fiscal] 2023, approximately 24.1% of the total contribution will go toward the normal cost and 75.9% will be used to reduce the unfunded liability. If the state adheres to the current 90% funding formula outlined in Illinois law, and all assumptions are met, most of the unfunded liability will be paid down over the next 24 years.”

SURS has hired search firm Korn Ferry to find a replacement for Wesley, and a replacement is planned to be announced in November.

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Tags: chief investment officers, CIO, Doug Wesley, Illinois, Illinois State Universities Retirement System, Scott Hendrie, SURS